The Incrementalist (or, What’s the Small Idea?)

Trying — with difficulty — to shake up a staid industry? It could be that you aren’t thinking small enough. Joe Fox, who has founded two industry-changing companies with his older brother, Avi, is a big believer in “mini-innovations,” small insights that add up to a big disruption. Their first company, a pioneering online brokerage called Web Street, was acquired by E-Trade Group for about $50 million in 2001. In 2006, they launched BuySide Realty, an online discount real estate brokerage that rebates 75% of its commission to home buyers. Last year they started Iggys House Realty, a subsidiary of Iggys House Inc. that allows sellers to list their homes for free in multiple listings services and on Realtor.com. Here Fox talks with Josh Hyatt for the MIT Sloan Management Review about how he became a toppler of traditions — and where he is likely to strike next.

What do you see in an industry that convinces you that there is room for grand-scale innovation?

FOX: I really believe you can’t force innovation; it’s not something that happens in a vacuum. You have to observe the world with a fresh eye. In the 1990s my brother and I were trading stocks on our own, and there was a company that had announced it was going public at $16 a share; the night before we said, “Let’s buy X number of shares at no more than $20 a share after it opens.” So the stock opens up, and goes up to $18.50, sits there for 10 minutes, then immediately runs to $26 before it closes. We waited for five hours for our broker to tell us whether we got in below the $20 per share limit that we set. And we did — which was great because the stock moved to $32 a share the next day. After that, it plummeted. We kept thinking about that “five hours” and we thought, “There has got to be a better way” and within the next year or two we saw what was going on with the Internet. That convinced us there has to be a way to reduce the cost of the transaction, create efficiencies and have a greater level of information. If I am going to innovate, I like to start with the desired result, that base idea. You have to think about what it is you want to do. I keep asking, what else could we do to be different — and better?

That’s when I look for “mini-innovations” — smaller steps that will get us there, like giving away free NASDAQ trades at Web Street, which is what we did. These ideas are not just from me, but from my whole team. I’m not the end-all of ideas.

Is there a “due diligence” phase when you are intensely studying an industry and identifying potentially profitable gaps — or do you just trust your own personal experience?

FOX: You have to be willing to spend the time to do the research and to investigate. Before we started Web Street, we saw that all of the information the stockbrokers had in the morning was from the night before — all the trades, the buys and the sells. In the morning, they’d tell their customers, “This is how much you have and how much buying power you’ve got,” and you used that same number throughout the day. It worked, because you would talk to your broker and say, “Buy 1,000 shares of IBM.” He’d say, “Let me take a look.” If you were short, you would mail in a check the old-fashioned way. You can’t do that if you are going to charge $14.95 a trade — as we wanted to do — you don’t want there to be any potential extra cash needed. You want to make sure you’ve got that covered.

But if there were a better way, wouldn’t somebody — especially someone with relevant experience — have found it already?

FOX: You know what a lot of people do? They say to themselves, if it could have been changed, it would have been changed. But you know what? That’s just not how life works. I don’t come from real estate and I don’t come from a brokerage house — and sometimes it’s better to come from outside of the industry. You know there’s an opportunity there if people tell you they would use your service. This isn’t about nuclear science; it’s about obvious needs. You know you are on to something successful when somebody says, “Why didn’t I think of that?” If you split the atom, the next guy isn’t going to wonder why he didn’t think of that.

Suppose everybody you talk to agrees that you’ve identified a problem that needs fixing — but also thinks that it’s one that you can’t solve?

FOX: I get more fueled and more excited by people saying that they love the concept and that it makes sense to them. With BuySide and, later, Iggys House, people said, “But how are you going to beat the National Association of Realtors?” “Let me solve that problem,” I told them. As long as you, an intelligent person, believe that a consumer would use a service like this — which is where I am going to make my money — then I’ll find the answers.

To get Web Street going, my brother and I went to the New York Stock Exchange and said, “We’re building an online brokerage firm. I want to make real-time information available. Can you give us the formulas for real-time balances, buying power and margin buying power?” I wanted us to calculate intraday, after every transaction, how much buying power you have left, what your balances are, how much money you’ve made and how much you’ve lost. Wouldn’t you want to know your balance in real time and how many more times you can trade? Of course you would. But when we went to the New York Stock Exchange and asked them the formula for buying power, they said, “We don’t know. It was built into the system 25 years ago, and you just can’t get that data in real time.” That made no sense to us. We figured we’d take a crack at it.

You make it sound like setting out to work out Rubik’s Cube. Did you have some secret knowledge that everyone else in the securities industry didn’t have? Were you just pathologically naive?

FOX: We knew enough to give it a try, that’s all. We created what we thought was the best possibility for the formula. When we launched in July 1997, we immediately started getting customers. But they were soon getting margin calls because of our formula. Because we didn’t have it right, the exchanges were demanding that investors put more cash into their accounts. We told customers not to worry, that we’d eat the trade. We changed the formula, and there were even more margin calls. It’s an expensive way to learn. But about three months in, we made one more adjustment to the formula — and the margin calls stopped coming. That meant that through trial and error, we figured out how to supply real-time account information when no one else had it. Of course, a year later the exchanges figured it out.

By the time you launched, wasn’t your innovation already passé? Weren’t companies like E-Trade and Ameritrade out there already?

FOX: It was in June 1996 that my brother and I decided to do online stock trading. E-Trade had launched in February, Ameritrade was nowhere to be seen. There were five online firms at the time; there were a couple of thousand online accounts. I started going out to raise money and nobody wanted to give me any. They said it was a fad and that no one would trade online. Meanwhile, E-Trade goes public in August 1996. Ameritrade buys a couple of firms, and they are online by early 1997. Then Schwab goes online. So by the time we raised a couple of million — all from individuals, 40 of them — and got out there in July 1997, there were 12 online brokers, but still only 2 million accounts. The difference in just a year was like seven years in the traditional world. We knew how we had to compete now. We spent $30 million in marketing over three years; other companies were spending that in a year.

How could you possibly ignore the fact that you couldn’t get a reasonable deal from institutional investors? Wasn’t their lack of enthusiasm telling you something about the quality of your idea?

FOX: I listened, but what I heard wasn’t convincing. People would say, “It’s a fad” or “Merrill is going to crush you.” But I knew it was a real business; it just seemed like common sense to me. We weren’t an easy sell, either. Remember, when we first came up with the concept, I wasn’t even 30 yet. My brother was 31. Who was going to believe us? What have we done? Have we ever run an industry-changing company before? It was tough.

Once you got up and running, did you count on your ability to innovate to prevent Web Street from getting crushed by bigger rivals?

FOX: We knew we had to keep thinking about what could make us a little different, especially since we didn’t have the money to spend on marketing. One day, I was driving and thinking: What would absolutely get people to want to use our services? Well, we could offer free trades. It occurred to me that if we could lower our transaction costs, we could make money from free trades. In my mind I went through our whole process, looking for inefficiencies. Sometimes little insights can look like real innovations. We were paying $25 to make a trade, and the market-makers were giving us a rebate of a penny per share. So I went to the clear-inghouse and negotiated a better rebate. “We’ll give you 2.5 cents a share,” they said. I also got our cost to $12 a trade. So on 1,000 shares, I would receive $25. This meant that our customers could make a trade of 1,000 shares or more on NASDAQ — which is where most of the activity was — and pay nothing, while we made money. A true win-win. Otherwise, it costs $14.95 for every trade. Eventually we got our costs down to $6 a trade by leveraging technology. Our business took off in months.

Offering free trades was all it took to gain some serious market share?

FOX: No, that’s what I call one of the “mini-innovations” that you have to keep executing. We were brainstorming all the time. If you are going to trade, wouldn’t you want streaming quotes like they have in a broker’s terminal? We went through four programming groups before we got that done. Two years into it, my brother — who is more of a traditional guy — made a comment about how he sometimes wants to touch and feel his money, to have somebody explain a new platform or which mutual fund is a better investment. That got us to thinking about what services we could offer in a brick-and-mortar setting. So we became a virtual online company with a branch office in Beverly Hills. That was in July 1999. It shocked people, but it turned out to be one of the best things we did. We opened four of them, and they became our second-best customer-acquisition tool. You have to have more than just that initial surge of innovation.

In that case, were you being innovative — or just contrarian?

FOX: We had a mind-set that made us willing to turn off of the path. At that time, everything was going online; you were going to be able to get your teeth fixed online, the way people were talking. People laughed at us, and some of our shareholders didn’t understand. But my brother was able to think it through logically, and from his clear-headed perspective, it was the right move. It made sense that people would feel better even if they just drove by our sign, or just knew it was there. It made Web Street feel more real. When people feel more comfortable, they put more money in — and we make more money on that money. Some innovations work because of luck, but the store-fronts had clear benefits. Of course, they are all E-Trade offices today.

You sold to E-Trade in May 2001, just after the Internet bubble broke open. Web Street had never posted a profitable year. Were you just out of steam?

FOX: We had profitable quarters, but we had to spend a ton on marketing. Actually, there are some ideas I still believe in that we never got to try at Web Street because the market changed on us. You can have the greatest idea in the world, but if the market turns against you then the best thing is not to fight the trend.

So did you just throw yourself at E-Trade?

FOX: We did approach E-Trade and we said, “You need to buy us.” We knew they wanted us — our branches, our partnerships, our technology. They needed the investment community to think of them as the roll-up player. When they bought us, the analysts went crazy over it and their stock went up by $400 million. We sold for $50 million.

So what did you end up believing about the market value of all of your original thinking?

FOX: My brother and I owned a little less than half of the company when we sold it. On the day we went public and our market cap reached $500 million, we calculated that we each had $100 million worth of stock as of the first trade. That seemed like a pretty good day. If we had been able to build the company more quickly, it would have been a greater opportunity — in the billions.

Given what you had been through with Web Street, it’s surprising that you would go into another unfamiliar industry — namely, real estate — and try to upend the business model there.

FOX: We weren’t looking to start another company or to change another industry.

So it just … happened?

FOX: It happened organically. There was time in between when I sat down and tried to think of what I could do, and out came nothing. I had some time on my hands, and a few bucks, and you know what happened? Nothing. Absolutely nothing.

So what made you decide that real estate was ready for your brand of innovation?

FOX: You can’t just sit down and decide that you are going to figure out how to innovate a gas station. You could create efficiencies and find all kinds of processes that you might be able to improve upon, but you are not going to innovate. What I saw in the real estate industry was a basic injustice, and I began questioning the establishment. That led us to start BuySide in 2006 and then IggysHouse.com.

You entered an industry that was sinking fast. Did your common sense let you down?

FOX: We took a risk. You can’t let a little thing like the perfect storm of market gyrations stop you, it just slows you down. We’re seeing more and more activity. I can gain a ton of share even if the market is stagnant, as long as we keep adding things. Besides, while the media wants everyone to believe that no one is buying a home, 5 million homes will be bought and sold in 2008.

Isn’t it dangerous to rely on your ability to keep innovating as your competitive edge?

FOX: I’m not the end-all in terms of coming up with ideas. I have a good inside team and a good outside team. When I was looking for an outside lawyer, I used to hear all the time, “Joe, you can’t do that.” And then I found one who said, “Joe, that has never been done before, but let’s see how we can make it happen.” I said “Bingo!” I love the guy. I have the support I need to figure out how we can make ideas work.

Who came up with the concept for BuySide Realty — charging home buyers a flat fee for help with the transaction, and then refunding them 75% of whatever commission the buyer’s agent would have received?

FOX: My brother and I were in Santa Monica three years ago looking for a vacation house. We met up with an agent who told us, “I’m glad to help you; here’s a Web site where you can search for a home. When you find one you like, drive the neighborhood and then I’ll help you with the deal.” We couldn’t help but think something was wrong with this picture; we were going to do all of the work, and the agent was going to make all of this money. Instead of saying to ourselves, “Hey, that’s the way it is,” we said there has to be a better way and we moved forward from there. There was an injustice. People were finding homes and agents were making the money. It just didn’t seem right to me.

You sound like a crusader. But aren’t you in it to make money?

FOX: I love the creative part, but you’ve got to make money for your investors. You have to constantly be selling the story.

Who heard the BuySide story first?

FOX: In April 2005, I called Joe Barr, who had been my president and CFO at Web Street, and I said, “I think we’ve got something even bigger this time, and we’re doing it.” A week later, we started Buy-Side. [Barr is currently president and CFO of Iggys House.] We raised $10 million from individuals. I went to potential investors and asked, “Have you ever bought a house on your own?” Yes, they said. “And did the agent make all of the commission?” I asked. The answer, again, was yes. “And was that fair?” They said no. OK, I said, so if you found a home and there was a company that could service the transaction once you found it, and rebated three-quarters of the buyer’s agent’s commission to you, would you use a service like that? The response, 100% of the time, was yes. That’s all I needed to hear.

Who else do you need to hear that from?

FOX: The people I bring in. They can’t just say, Oh, I like the idea. They’ve got to believe in it. They’ve got to live it and breathe it. When people say, “Joe, I love the idea and I’m willing to work unpaid until we’ve got what it takes to raise money” — that’s when I know I have believers on my hands.

But how do you know if they are true believers in your business model, or true believers in getting themselves a job?

FOX: You don’t. You do the best you can. I want them to get to the point where their spouses believe in it, and are excited about the opportunity. When somebody says, “My wife had an idea about this,” I have confirmation that these people really believe in it. I want everybody to share their ideas, and I make sure they know that.

Can you just get useful ideas by begging for them?

FOX: There are ways of doing it. At BuySide, one of the first things I did was to get a contest going. I offered 2,000 stock options for anybody who came up with a mission statement we ended up using. Everyone submitted mission statements based on what they thought we should be all about, and they were all somewhat similar: people believed we were changing the industry, or helping consumers by putting cash back in their pockets. That opened up everyone’s thinking, and gave us something to talk about.

By “us,” you mean the management team?

FOX: I mean everybody who works here. We have lunch together every other Friday. Everybody gets on the speakerphone at the same time — from San Diego, Miami, Chicago, and Texas. At this point, we have about 50 employees.

And what do you do at those meetings that keeps the mini-innovations coming?

FOX: I ask people to read about the industry, stories about innovative companies in the online real-estate space like Zillow and Trulia. And I want to know what they are hearing from their friends who are still traditional real-estate agents. You can learn a lot from that. What are the next things we should be focusing on? What stumbling blocks are ahead? Not everybody will be fired up, some people will be naysayers. Sometimes you are so deep in an industry, and have been doing it for so long, that you can’t imagine it being changed even more than we have already changed it.

Is there any way to help those people visualize what you are describing — given that it hasn’t existed before?

FOX: I always use a pad of paper to lay out my five-year vision. With Web Street, I sketched the concept by drawing a computer screen — what you’ll see on it, what advantages it will offer consumers, and the different levels of service we’ll provide. I’d show them what it would look like three years from now, then five years from now. And that was before one line of code had been written. You have to know your product, what the industry is all about and what you are going to do.

But you’re not in any one industry — unless you consider yourself to be a manufacturer of mini-innovations.

FOX: We’re all about improving efficiency by using what’s out there. I didn’t invent the Internet or MLS listings. In fact, I went to five different colleges, and never graduated. The technology makes it all more efficient. My real estate agents are salaried and will each do at least 15 transactions a month; from their desks, they’ll help with the negotiation, the pricing, the contracts, and everything all the way to the closing. We can give you three-quarters of our commission back, and we’ll still make money. Our average rebate has been $11,000.

That sounds like a pretty hefty incentive for people to do most of their own house-hunting. So what does Iggys House and its free listings add to that?

FOX: We were a couple of months into BuySide and into the rebating, and I saw that we were going to need to spend a lot of money on marketing, just to educate the consumer. I thought there had to be a lower-cost way. If you’re selling a home, there’s an 80% chance you’ll be buying one, too. Wouldn’t it be wonderful, I thought, if we could acquire customers by offering them free access to the listings services? I figured that would be too expensive, but one day I asked one of my managing brokers and she told me that it is all included in our $100 a quarter we pay in dues and we could list as many homes as we wanted. Right then, a light went on. We’ve done about 6,000 free MLS listings, and we haven’t spent any money on advertising. Once you sell a house through me, you’ll probably buy through me, too. And we keep adding services — we’ve got an innovative referral program where traditional agents pay us for leads that turn into transactions. We just launched a mortgage brokerage in a couple of states; my loan officers are salaried, and their bonus depends on how well customers feel they were treated.

You’ve been very thorough. With all the mini-innovating you do, how do you know when you have changed an industry as much as you can?

FOX: You can’t change an industry if you don’t have a large footprint. We can’t be finished until we are a household name.

Speaking of names, should I have been calling you “Iggy” all along?

FOX: No. Iggy was the nickname for an old guy — not sure what his real name was — who lived next door to my family when we were growing up here in Chicago. My mother was working three jobs to support us, so my brother and I spent a lot of time talking with the guy. He told us a lot of funny stories. Thirty years later, we’re trying to come up with a company name and my brother says: “There’s something about ‘Iggy.’” I loved it right away. I knew it was creative genius.